How Banks Will Make Up For Lost Overdraft Fees

By Daniel Indiviglio

Way back in October, I wrote about what regulators' decision to eliminate overdraft fees could mean for consumers. One likely result: no more free checking. An article today in the New York Times on the same topic also foresees this as a possibility, but offers a few more as well. One thing is for sure: consumers will be paying for their overdraft fee-free lives one way or another.

As I said previously, don't expect banks to simply accept lower profits. They will lose billions of dollars over the next few years by not being able to collect overdraft fees. As we learned with last spring's credit card regulation, when regulators change the rules, banks don't accept less revenue: they adapt. So how might they change their strategies to continue to profit off checking without the luxury of overdraft fees?

Here are some suggestions from the Times article:

Some of the less creative institutions will tack on monthly fees again and hope customers don't flee. Or they may raise the minimum balance requirements that some banks already have. If you value having access to a particular branch in your neighborhood, you may have no choice but to comply unless you're willing to go to the trouble of switching banks.

Other banks may try something like what Fifth Third Bank has done with its Secure Checking Account package. The bank charges $7.50 a month, but it throws in identity theft protection, which millions of consumers already pay at least that much for elsewhere. Banks could add other services, too, say an hour with a salaried financial planner (who doesn't push the bank's own products).

Another option is the à la carte model, where banks offer bare-bones checking for free, but let people pay extra for things they truly value. For a few dollars a month, say, you could use any A.T.M. on earth free.

But the most popular option seems to be to get retailers to pay for a big part of free checking, not bank customers.

Why retailers?

Well, remember our old friend the debit card, which upended the industry a decade or so ago? Banks don't just get overdraft revenue. They also get a cut of the fees merchants pay when someone uses a debit card, and banks generally get a bigger cut if cardholders sign for their purchase instead of using their PINs.

You see where this is heading, right? If banks can get enough people to use their debit cards and sign for their purchases often enough, it will go a long way toward keeping checking free and even subsidizing better interest rates or rewards. (It may also cause merchants to raise prices to cover those card fees, alas.)

Of all these possibilities, I wouldn't be surprised if banks create greater incentives for their customers to debit and sign, as this last option above suggests. The article also later provides an example of exactly what I would expect:

A new company called PerkStreet Financial offers a different twist on free checking. You pay no fees for your account as long as it remains active, and you get about 1 percent back of every debit card purchase when you sign while buying (and for Web or recurring charges, say for monthly bills). You then redeem that 1 percent in the form of perks (hence the name) like gift cards from Starbucks and iTunes.

If you use the debit card enough, the merchant fees incurred will easily pay for the measly 1% rewards consumers accumulate -- and the banks' lost revenue from not being able to charge for overdrafts. But this isn't really that good of a deal for consumers. This will simply cause retailers to charge more for their products, since their transaction costs will increase with more use of debit cards plus signing.

Of course, from a psychological perspective, consumers won't realize that they're paying marginally more from retailers, but will love the fact that they're getting rewards for using their debit cards. From an economic perspective, however, the lost overdraft fee revenue that used to be paid by a small group of consumers will now be spread out over a much larger population. That's good for those who were regular overdrafters, but bad for everybody else.